There have been studies and data in recent years showing that social media postings are fueled by a Fear of Missing Out - FOMO - and a Fear of Joining In - FOJI. These social media-induced feelings can be considered like subtler and more sophisticated emotions than the old Wall Street mantra of greed vs. fear.
The ongoing bull market in growth stocks is leading to FOMO (greed). That feeling is particularly building up among investors currently sitting on cash.
On the other hand, all-time highs in equity markets and the 10-year anniversary of Lehman Brothers’ bankruptcy means plenty of investors are starting to feel the FOJI (fear) too.
Yet, the way we fight these counter-intuitive emotions can be just as wrong.
"Be fearful when others are greedy and greedy when others are fearful."
This quote is still a great way to illustrate how a contrarian view can help you over-perform the market averages by buying depreciated assets or selling overrated ones.
Now, despite the best intentions behind these ideas, they are unfortunately often misunderstood or used the wrong way by many investors.
While mean reversion theory and similar approaches can help day trading strategies, it can be fundamentally wrong when applied to a long-term investment plan in individual equities.
Let’s review why.
How to fight FOJI: Start your position already!
FOJI is the anxiety that prevents you from starting a position. While FOJI can successfully prevent you from making a mistake, it can be much more damaging if we look at the missed opportunities.
Over your life as an investor, as long as you maintain a balanced and diversified approach, taking into account market, sector and company risk, the biggest risk you are exposed to is the one of missing a significant opportunity.
Let’s say that you come across The Trade Desk at the end of 2017 and you like the company. At the time, the stock had just delivered an amazing performance of 55% in a year, moving from $30 to $46 a share.
Here are the typical ways FOJI would impact your reasoning and prevent you from starting a position in TTD at the time:
- “The stock has run too much”
- “The company is overvalued at this price”
- “I will buy if it drops back down to $40 or lower”
Here’s the thing: If you have a long-term view, past performance and arbitrary price target are two terrible reasons to buy a stock. But they are even worse reasons not to buy a stock.
If you let FOJI take control and decided not to invest in TTD, you have already missed on more than 200% gains in a matter of months.
That’s why if you have identified a company that you want to invest in, because you like the business model or the leadership in place, the best action is likely to start a position now.
Many investors have achieved a fantastic performance over the last decade thanks to FAANG stocks: Facebook (FB) Apple (AAPL) Amazon (AMZN) Netflix (NFLX) and Alphabet (GOOG) (NASDAQ:GOOGL). But how many investors have watched these companies (or the broad market) from the side line? They like the businesses, the products, they believe these companies have great leadership and strong potential for the years to come, yet they refuse to start a position in them because they irrationally think these stocks will crater as soon as they join the bandwagon.
Risk aversion is too often making people miss on some of the biggest opportunities of our time. People claim they want to buy low and therefore avoid buying altogether, even though there is no way to know for sure whether the current market capitalization of a company will turn out to be lower or higher in a few years.
How to fight FOMO: Don’t buy all at once!
If you managed to conquer your FOJI temperament, it would be a terrible mistake to let greed take over and go “all-in”.
FOMO is the anxiety that makes you buy too big of a position because you think you are looking at the opportunity of a life-time.
Dollar-cost averaging is a favorite practice of Benjamin Graham, Warren Buffett's mentor. It means investing a set dollar amount in the same investment at fixed intervals over time. This leads you to buy more shares when prices are low and fewer while prices are high.
Similarly, being patient and buy the dips when the opportunity occurs can lead you to buy more shares at lower prices.
Let’s say you would like to add TTD to your portfolio and decide to start a position today. Let’s say you are targeting to eventually own 500 shares of The Trade Desk at the current price.
What about buying 100 shares today, only 20% of your intended investment?
- If it drops 15% in the next month following negative rumors, bad news cycle or a temporary market dip: you can always seize the opportunity to buy 115 or more shares at that lower price.
- If it runs 15% up in the next month: you can dollar-cost average by buying 85 shares with the same dollar amount.
That’s why – to replace the “buy low, sell high” adage – the real actionable mantra for long-term investors should be “start your position now and stage your buys”.
If you stage your buys, using dollar-cost averaging or buying on dips, you are more likely to get a lower cost over time. You will have successfully built a position in your portfolio you are satisfied with. And you are less likely to perceive a drawdown in the stock price negatively, therefore overcoming the potential risk of panic selling.
Let your portfolio concentrate for you
The vast majority of financial literature will tell you to diversify. Yet, there is a persisting belief that concentrating your portfolio only on your few highest convictions can help dramatically your performance. After all, that’s how Warren Buffett achieved 21% compound annualized return over his career. In his 20s, he put all his money into Geico. Very recently, he added more and more to his position in Apple (25% of his portfolio as of end of June 2018).
Firm conviction can be the enemy of truth. Even some of the best investors in the world have made mistakes, concentrating too much into only a few bets. A good read on some of them is the book Big Mistakes: The Best Investors and Their Worst Investments (Bloomberg) by Michael Batnick.
One of the easiest ways to avoid being carried away by your own convictions is to cap your maximum exposure to a single company from a cost-basis perspective.
There are many opinions out there about what that maximum exposure to a single company should be. It all comes down to your risk profile, time horizon and goals.
Overall, if you don’t want to let one single company put your overall portfolio performance at risk, a cap from 5% (at least 20 balanced companies in your portfolio) to 10% (at least 10 balanced companies) is reasonable.
I have found my personal preference slightly toward the risky end of the spectrum with no less than 12 balanced companies in a portfolio, i.e., an 8% maximum exposure to a single company on a cost-basis [100/12].
Imagine you decide to invest $120,000 today and invest it equally in 12 companies, resulting in 12 individual investments of $10,000, each representing at most 8% of your cost basis (10,000/120,000).
Now, a year later, let’s say one of your investment is up 200%, two companies went bankrupt and all 9 other companies are unchanged.
Here is how your portfolio would look like:
As you can see:
- From a cost-basis perspective, you have allocated only 8% of your portfolio to company A.
- From a current value perspective, your portfolio is 25% allocated to company A.
Your portfolio has concentrated into company A simply because it is the “biggest winner,” the investment that has performed the best over time.
If you were to invest additional funds to that portfolio, it would be perfectly fine to add more to our existing position into company A as long as it remains no more than 8% of the new funds invested in the portfolio.
If you focus on your investment risk allocation from a cost-basis perspective rather than your current value, you will benefit from two leverages:
- It will prevent you from adding too much to your losers.
- It will encourage you to add to your winners.
Your winners will represent a larger part of your portfolio simply because they are winners, not because you took unnecessary risk.
We are hardwired to add to our losers to be break-even faster and sell our winners to secure our gains.
That’s inherently a recipe for a losing performance because winners tend to keep on winning and losers to keep on losing.
You might be convincing yourself that you are “buying low”, but if you keep adding to company L simply because it is down 50% and "it has to come back up at some point,” you might end up with a big loser that offsets most of the performance of your winners. How many investors have "BTFD" when the parent company of MoviePass, Helios and Matheson (HMNY), was down from $12 to $3 thinking it was poised to bounce back, only to find out the stock would go down to 0?
You might be convincing yourself that you are “selling high”, but if you keep selling your winners as soon as they reach, say 100% gain, they will never compound to a significant portion of your portfolio and you might miss on the single investment that would have driven your market over performance for the years to come. How many times investors out there have "secured" their gains in AAPL over the last decade, only to find out they should have been holding all along?
Outliers, massive multibaggers over the years like Apple, Amazon, Netflix or Nike (NKE), are the very companies that are enabling the S&P 500 to grow at a 10% annualized return over the last century. They more than offset the other companies that perform far under the average.
If you don’t let the few investments that are over-performing take a bigger piece of your portfolio over time, you will be left with average performers and a bunch of losers slowly overtaking your portfolio allocation.
Let your portfolio concentrate for you. If your top 3 investments become more than 50% of your portfolio, they got there themselves, not because you blindly invested in them in an unreasonable way. Keep track of your cost-basis and try to maintain the cost allocation of every single individual stock of your portfolio below 8%. Let the current concentration of your portfolio be a result of its sheer performance, not a result of your firm convictions.
Recognizing your natural instincts and tendencies by having a plan is the most important step toward successful investing.
Use simple techniques like starting your position now, staging your buys, dollar-cost-averaging, buying on dips, capping single company on a cost-basis exposure, letting your portfolio concentrate for you and investing more in your winners over time.
My vision is mainly focused on the inexorable rise of the App Economy, the range of economic activity surrounding mobile applications. My investment plan and asset allocation are a result of mega-trends I have identified and in which I take high-conviction individual bets, ideally for the decades to come – unless the story changes.
Here are some of the mega-trends I am investing in:
If you are a like-minded investor eager to find a community to share and discuss ideas with, please consider joining the App Economy Portfolio.
The service unlocks access to my real-money portfolio tracker, live alerts on trades, monthly high-conviction and timely investment ideas.
Disclosure: I am/we are long TTD, FB, AAPL, AMZN, NFLX, GOOG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.